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Knowledge Development Box

The Irish Finance Bill which was published on Thursday, 22nd October, introduced legislation for “taxation of companies engaged in knowledge development”.

This new legislation which is otherwise known as the introduction of “a Knowledge Development Box” was first announced by the Minister for Finance in Budget 2015. In the past 12 months the Department of Finance have engaged in a consultation with different stake holders who get their views for drafting legislation. While many of the issues raised by stakeholders seem to be addressed, there are still possibilities that the “Knowledge Development” legislation will change over the course of the Finance Bill or in the coming years in light of further representation. The legislation will bring an effective tax rate of 6.25% on qualifying profits. It will also be the first OECD compliant regime for the taxation of qualifying patents and other relevant Intellectual Property.

How Does It Work

The draft legislation provides that the “modified nexus approach” as endorsed by the OECD will apply to effect a reduction in qualifying profits. The formula applies as follows:-

The result of this calculation gives the qualifying profit to be taxed at 6.25% rate. Effectively qualifying profits will be reduced by 50% so that they will be taxed at an effective tax rate of 6.25%

What will qualify?

As can be seen from the formula above, it will be “qualifying expenditure” which will be taken into account. The qualifying expenditure must be relating to “qualifying assets”. In addition the expenditure must lead to the development, improvement of creation of a qualifying asset and be incurred by a company wholly exclusively the carrying out of certain R&D activities. A “qualifying asset” will include patents and copyrighted software as well as new “and novel” inventions for company with turnover of less than €7.5M

However, the definition of “qualifying expenditure specially excludes any acquisition costs in relation to a qualifying asset. That is while acquired IP needs to be taken into account in the calculation it is not qualifying expenditure.

Also the payments to a group member for R&D are excluded from qualifying expenditure although outsourcing payment to third parties will qualify where the service party is in another EU Member state.
However, it is not clear exactly what income will be attributed to the value of the qualifying amount.

When does it apply?

The new legislation takes effect for accounting periods beginning on or after the 1st January 2016 and ending 31st December 2020. Any claim for the deduction must be made within 12 months of the relevant accounting period.

Although the legislation takes effect for accounting periods beginning after the 1st January 2016, costs prior to that date will be relevant in calculating the relief. Any Intellectual Property acquired prior to 1st January 2016 will continue to form part of the relevant calculation in future period.

Documentation

Companies who wish to claim the relief are required to maintain detailed records. It will be important going forward to ensure that the R&D qualifying expenditure is “qualifying expenditure” and relating to a “qualifying asset”. Also, where R&D expenditure is outsourced, the documentation relating to this will be relevant. It will be interesting to see what Revenue guidelines are issued in relation to the documentation when the legislation is finalised

What will be the impact?

The legislation is to be welcomed on the basis that it is an OECD compliant legislation to encourage R&D expenditure on the creation of intangibles.
There is a possible likely distinction between start-ups and existing multi-national companies in their ability to use the relief and it may require re-structuring of existing operations to best maximise the relief going forward. Also, the relief should prove attractive for indigenous companies carrying out all its R&D itself.

Finally, what is clear is that the “Knowledge Box is yet another tool which may attract companies who are looking at investing in Ireland and want to legitimately maximise their profits and overall expenditure on R&D.

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